Coase's Theorem and Intellectual Property

Hal Finney (
Tue, 22 Dec 1998 09:50:23 -0800

Coase's theorem basically says that you can solve externalities by introducing property rights. The classic example is a railroad engine which sends off sparks, causing fires in farmers' fields. You can give the farmers the property right not to have the engine cause fires, in which case the railroad owners either have to fix their engines, or purchase the rights to cause fires from the farmers. Or you can give the railroad a property right in spark emissions, in which case the farmers either have to fireproof their fields (and fight resulting fires), or pay the railroad to suppress sparks.

(These are two sides of the same idea: there is a "right to emit sparks
that may cause fires", and in one case the railroad starts off owning it, and in the other case the farmers start off owning it.)

Either way, the result is the same, according to Coase. Neglecting transaction costs (reasonable if there aren't too many farmers to negotiate with), you get a socially optimal balance between spark suppression and fire fighting. The distribution of wealth is different, though; the farmers paying the railroad, or vice versa. But the expenditures on technologies to solve the problem will be the same, and will be optimal based on the underlying costs.

(I should mention that my understanding of Coase's theorem comes from
secondhand sources; I have not read his original work.)

Coase's theorem is controversial among libertarians. Some will seize on the idea of property rights to solve problems usually left to government. Pollution a problem? Just give people property rights to clean air, and polluters have to pay when they pollute. Now you have a market in pollution rights, and Coase's theorem shows that you will get a good result - probably better than what you'd get via government regulation.

On the other hand, introducing new property rights smacks of coercion in itself, to many people (as we have seen here). Property rights in clean air and water may be acceptable; property rights to unobstructed views (common in some areas) begin to cross the line; and intellectual property rights are outside the pale.

Property rights do involve redistribution of wealth, as in the railroad example. No doubt there would be a fervent argument between farmers and railroad owners as to what the proper initial allocation of the right to cause fires is. But from the larger point of view, the initial allocation is not important; what matters is efficient use of resources. The property right achieves that, regardless of how it is initially allocated.

It has been argued here that intellectual property favors the rich, or the well-established, or the uncreative, or closed-source software developers. This may be the case. There are rules for creating new intellectual property, considerable costs in doing so, and these will favor those who plan to profit from the resulting rights.

But in the larger sense, once the rights exist, Coase's theorem comes into play. The participants will act in such a way as to maximize the value of those rights. This will inherently involve finding the most efficient and productive ways to use those property rights. And everyone benefits from the resulting efficiency.

Most participants here understand the benefits of the free market. Goods flow to where they will bring the best prices. People work to supply that which is in demand. The invisible hand leads to efficient allocations of resources, without central planning. But all this depends on property rights. That is the foundation which allows prices to be set and a market to exist.

The same principles will apply to intellectual property. It allows a market to exist, prices to be set, and property rights to be exchanged. The invisible hand will once again lead to an efficient allocation of resources. The market works just as well for intellectual property, and other, even more abstract forms of property which we may create in the future, as it does for physical goods.